Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Nautilus, Inc. (NYSE:NLS) makes use of debt. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Nautilus's Debt?
As you can see below, Nautilus had US$14.4m of debt at June 2020, down from US$20.6m a year prior. But it also has US$45.7m in cash to offset that, meaning it has US$31.2m net cash.
How Healthy Is Nautilus's Balance Sheet?
The latest balance sheet data shows that Nautilus had liabilities of US$78.2m due within a year, and liabilities of US$37.7m falling due after that. Offsetting these obligations, it had cash of US$45.7m as well as receivables valued at US$39.1m due within 12 months. So its liabilities total US$31.1m more than the combination of its cash and short-term receivables.
Of course, Nautilus has a market capitalization of US$655.1m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Nautilus boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Nautilus made a loss at the EBIT level, last year, it was also good to see that it generated US$16m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Nautilus's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Nautilus may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Nautilus actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
We could understand if investors are concerned about Nautilus's liabilities, but we can be reassured by the fact it has has net cash of US$31.2m. And it impressed us with free cash flow of US$51m, being 314% of its EBIT. So we don't think Nautilus's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Nautilus , and understanding them should be part of your investment process.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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